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The Five-Year Itch

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Next to preparing the annual budget, the exercise that many CFOs dread most is creating a five-year plan. The document can take months to craft, is impossible to get right, and generally becomes obsolete within six months. Why, then, are companies still wedded to it?

The answers are varied. Some CFOs, especially those at capital-intensive companies or municipalities, produce five-year plans to support bond issues or other long-term capital financing. Others do them simply because their bosses want one. No matter why they do it, however, CFOs agree on one thing: after year two, it's all guesswork.

"For some reason, the best year is always the fifth year," laughs Jim Bell, director of corporate finance at Huntsman Corp., a petrochemical maker headquartered in Houston. "Truthfully, once you get out past two years, it's so fuzzy that it's fairly meaningless."

Bell has done a five-year plan approximately every four months for the past year and a half, even before the privately held company defaulted on a bond payment and had a change of investors. He and his finance team have gotten so good at creating the plan that he says it now takes them only two to three weeks to complete the next version. "We've had all the big consulting firms in here in the past year representing potential investors, and they all want a five-year plan," Bell adds.

Oddly, even the lenders that demand the plans acknowledge their fallibility. "There's a high degree of uncertainty the further out you go," says John L. Daniels, senior vice president in the commercial-banking group at Bank of America Corp.

Uncertainty notwithstanding, BofA still requires that companies produce forecasts that cover the duration of nearly any loan they request. "We're obviously asking so we understand the risk of a deal," says Daniels. "We're looking for the cash-flow perspective and how we're getting paid. We build our loan agreements and covenants on that information."

Dead or Alive?

While five-year plans may be a great tool for banks, many CFOs think they're a big headache and will jettison them at the first opportunity. That's what Dawson Cunningham, CFO of Akron, Ohio-based Roadway Corp., did in 1996 after his company was spun off from its parent. Roadway had no debt until 12 months ago, so it could easily drop such plans, says Cunningham.

"[The parent company] required that we do detailed five-year plans that contained, basically, a lot of text outlining goals and the financial forecasts relative to operating results," recalls Cunningham. He thinks the document, which took two months to complete, was useless. "The problem with a plan is that it gets put on the shelf," he says. "It's not a living document." Today, Cunningham leads Roadway through strategic-planning exercises on an "as-needed basis."

"We're heavily driven by the economy and cycles that we can't forecast," he notes. "We've found that the best thing to focus on is not the process of creating a five-year plan, but the process of creating benchmarks, and reviewing your progress against those benchmarks."

But there are CFOs who actually like five-year plans. David Schroeder, CFO of Brady Corp., a manufacturer of high-performance identification systems in Milwaukee, says he'd do a five-year plan even if he didn't have to.

"The process is very useful," states Schroeder, who says it takes his team four months to create a five-year plan. "We do five-year plans to give ourselves a longer-term view to achieve long-term growth goals. We have grown through a blend of acquisitions and internal growth, so we want to know what kinds of resources we need to develop acquisition pipelines, and what infrastructure we'll need to do it."

Schroeder and his team produce a document that is then broken down into division-specific action plans. It also includes major milestones that he and his team track over time. "For us, it's a living thing," he says. "It helps us communicate with other parts of the organization about how we plan on executing our mission." If Schroeder sounds unusually positive about the plans, it should be noted that he and his team complete them only every two to three years.

Crapshoot

Critics of five-year plans can point to the events of the past two years to argue the futility of forecasting anything further out than a year or two. Even that can be a crapshoot — although, like craps, some are better at it than others.

"There's no doubt that there's a connection between quality of management and ability to forecast," says BofA's Daniels, "but with that said, even some of our best clients have missed forecasts, and no one predicted the downturn."

That includes BofA, which estimated in January that it would write off $1.2 billion in bad loans for Q4 2002. Daniels says the bank's problems were due to "economic factors that were outside of how we evaluate the quantity and quality of historic and projected earnings."

In other words, stuff happens. Scenario planners have long argued that it is these "outliers" — with the lowest odds of occurring — that have the greatest potential for affecting a company's long-term viability. But five-year plans rarely account for outliers.

For that reason, some companies use a variety of inputs often used for scenario planning -- interviews with industry experts, suppliers, industry associations, and economists -- to create five-year plans. But unlike in scenario planning, where the aim is to develop strategies for possible futures, CFOs developing five-year plans today are expected to turn revenue projections into everything from earnings in 2004 to cash-flow figures in 2007.

Such forecasts, of course, are composed of roughly one part science and three parts wishful thinking.

Bell says Huntsman usually relies on raw-material pricing data from the Chemical Manufacturers Association to compile pricing forecasts for its five-year plan. But such things as war and terrorism have made even that data less than reliable. Comments Bell, "I heard a report yesterday that said three things could happen to the price of oil if we go to war with Iraq -- it could go up to five dollars, down to a dollar, or stay the same. I mean, I could have arrived at that conclusion without doing any research at all."

There's some consolation in knowing that even the bankers feel the CFOs' five-year planning pain. "I have a great deal of sensitivity to it," says Daniels, whose group routinely prepares multiyear forecasts. "The hardest part is knowing what you don't know."